Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions The Two Greatest. Great Moderation vs Great Recession M. D. Gadea1 A. Gómez Loscos 2 G. Pérez Quirós3 1University of Zaragoza 2Bank of Spain 3Bank of Spain and CEPR Conference in Honor of James Hamilton. Federal Reserve Bank of San Francisco The views expressed here are those of the authors and do not express the views of the Bank of Spain or the Eurosystem. Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Where Danger Lurks "Where Danger Lurks", Olivier Blanchard, IMF Finance and Development (September, 2014) Until 2008, mainstream U.S. macroeconomics had a benign view of economic fluctuations in output and employment. The crisis has made it clear that this view was wrong and that there is a need for a deep reassessment. Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Where Danger Lurks "Where Danger Lurks", Olivier Blanchard, IMF Finance and Development (September, 2014) Until 2008, mainstream U.S. macroeconomics had a benign view of economic fluctuations in output and employment. The crisis has made it clear that this view was wrong and that there is a need for a deep reassessment. Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Where Danger Lurks We thought of the economy as roughly linear, constantly subject to different shocks, constantly fluctuating, but naturally returning to its steady state over time. Even when we later developed techniques to deal with nonlinearities, this generally benign view of fluctuations remained dominant. Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Where Danger Lurks We thought of the economy as roughly linear, constantly subject to different shocks, constantly fluctuating, but naturally returning to its steady state over time. Even when we later developed techniques to deal with nonlinearities, this generally benign view of fluctuations remained dominant. Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Where Danger Lurks From the early 1980s on, most advanced economies experienced what has been dubbed the "Great Moderation". Whatever caused the Great Moderation, for a quarter century the benign, linear view of fluctuations looked fine. The Great Moderation had fooled not only macroeconomists. Financial institutions and regulators also underestimated risks. Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Where Danger Lurks From the early 1980s on, most advanced economies experienced what has been dubbed the "Great Moderation". Whatever caused the Great Moderation, for a quarter century the benign, linear view of fluctuations looked fine. The Great Moderation had fooled not only macroeconomists. Financial institutions and regulators also underestimated risks. Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Where Danger Lurks "Dark corners". Situations in which the economy could badly malfunction. We thought we were far away from those corners, and could for the most part ignore them. Measuring systemic risk, can be used to give warning signals that we are getting too close to dark corners, and that steps must be taken to reduce risk and increase distance. Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Where Danger Lurks "Dark corners". Situations in which the economy could badly malfunction. We thought we were far away from those corners, and could for the most part ignore them. Measuring systemic risk, can be used to give warning signals that we are getting too close to dark corners, and that steps must be taken to reduce risk and increase distance. Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions One lesson and one assumption Dark corners should be seen in advance and can be seen in advance. Early warning systems. Great Moderation is over (otherwise we would be still fooled). Thanks to its end, we can observe the dark corners 1+1=2. Two missperceptions of the Great Recession?? Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions One lesson and one assumption Dark corners should be seen in advance and can be seen in advance. Early warning systems. Great Moderation is over (otherwise we would be still fooled). Thanks to its end, we can observe the dark corners 1+1=2. Two missperceptions of the Great Recession?? Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions One lesson and one assumption Dark corners should be seen in advance and can be seen in advance. Early warning systems. Great Moderation is over (otherwise we would be still fooled). Thanks to its end, we can observe the dark corners 1+1=2. Two missperceptions of the Great Recession?? Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Searching for dark corners 1 Early warning systems. "The failure to predict the Great Recession. The failure of Academic Economics? A view through the role of credit" (Gadea and Perez-Quiros, JEEA 2014) 2 Great Moderation is over "Great Moderation and Great Recession: From plain sailing to stormy seas?" (Gadea, Gomez-Loscos and Perez-Quiros, Documento de Trabajo Banco de España, 1423, Working Paper CEPR DP10092) The Great Moderation in historical perspective. Is it that great? (Gadea, Gomez-Loscos and Perez-Quiros) Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Searching for dark corners 1 Early warning systems. "The failure to predict the Great Recession. The failure of Academic Economics? A view through the role of credit" (Gadea and Perez-Quiros, JEEA 2014) 2 Great Moderation is over "Great Moderation and Great Recession: From plain sailing to stormy seas?" (Gadea, Gomez-Loscos and Perez-Quiros, Documento de Trabajo Banco de España, 1423, Working Paper CEPR DP10092) The Great Moderation in historical perspective. Is it that great? (Gadea, Gomez-Loscos and Perez-Quiros) Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Outline 1 Motivation 2 The failure to predict the Great Recession 3 The Great Moderation is over 4 Conclusions Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Outline 1 Motivation 2 The failure to predict the Great Recession 3 The Great Moderation is over 4 Conclusions Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Searching for dark corners IMF Global Financial Stability Report. September 2011 "Credit to GDP growth is a particularly reliable indicator of recession when the experiences of both advanced and emerging economies are considered together" Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Searching for dark corners Why nobody saw the credit crunch coming? LSE, Nov 2008 Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation vs Great Recession Motivation The failure to predict the Great Recession The Great Moderation is over Conclusions Why nobody saw the credit crunch coming? The failure of economists to foresee the Great Recession has been globally commented... and has been widely criticized Olivier Blanchard (2014). Fooling of the Great Moderation Paul Krugman (2009) "Profession blindness to the possibility of catastrophic failures in the market economy" Colander et al (2009) "Misallocation of research efforts in economics"..."an insistence on constructing models that disregard the key elements driving output in the real world" Smets and Wouter (2007) and others do not incorporate any financial accelerator mechanism Gadea, Gomez-Loscos and Perez-Quiros The Two Greatest. Great Moderation